Repealing “Citizenship Taxation”: The difficult we do today, the impossible takes a little longer

difficultwedotoday

The Alliance For The Defence of Canadian Sovereignty is prosecuting a lawsuit against the Government of Canada. The lawsuit is for the purpose of “striking down Canada’s FATCA IGA”. The Canada FATCA IGA lawsuit is providing citizenship leadership and FATCA education for the world.

The primary purpose of FATCA is to enforce U.S. “citizenship taxation”. In reality, U.S. “citizenship taxation” is taxation based on the immutable characteristic of “place of birth”.

Although “citizenship taxation” may have always been U.S. law it has NOT always been U.S. practice. In fact, the U.S. made no attempt to enforce “citizenship taxation” until sometime after the 2008 financial crisis. The reasons for the enforcement are not entirely clear, but the enforcement of “citizenship taxation” has been a “life altering” event for Americans abroad. For Americans abroad, “citizenship taxation” is NOT a theoretical concept.  It is a reality that impacts on virtually every aspect of their lives. It directly affects their career opportunities, their retirement planning and (for those Americans with an “alien spouse”) their marriages. This has led to cries of anguish and pleas for change. It has led to a huge surge in the “relinquishments” of U.S. citizenship. On March 2, 2015 I participated in a session for U.S. citizens in London. A comment about the about the session and the recent enforcement of U.S. citizenship taxation included:

I would add that it was evident that some people at the meeting have suffered significant mental anguish, either now or in the past. These are good people, who had tried as US citizens to do the right thing, but who have been stymied by rules and complexities of the IRS code which, to paraphrase John, “no rational person would ever have suspected or guessed would remotely be true”.

I find the damage to mind and body to be one of the most heart-rending things about this whole mess. Someone wrote to me recently, “So I’m not alone in my panic!! Yeah, there’s been plenty of sleepless nights. Just can’t get it out of my head.” Many reading have had that experience.

I am waiting for the day that someone in government finally notices and apologies, perhaps admitting, “We tortured some folks.”

This is the reality of how citizenship taxation (of at least U.S. style) affects the lives of those impacted by it. This is NOT theoretical. This is actual damage and harm. I am writing this post from Austria where I am hearing similar stories from Americans abroad. It is very clear that the “emotional damage” can be understood only by those who have experienced it. The damage was documented in the numerous letters from Americans abroad to the House Ways and Means Committee describing the effects of citizenship taxation.

In the short term, the implementation of FATCA will exacerbate the “pain”. On the other hand, the “pain” may be the necessary impetus for change. In order for there to be “change”, there must be some discussion and analysis of the issue. In order for there to be analysis, there must be awareness of the problems of “citizenship taxation”. That’s the reality of what has been unleashed by FBAR, FATCA, PFIC, CFC and the whole “Alphabet Soup” list of provisions which have changed the lives of Americans abroad.

The good news is that awareness of “citizenship taxation” is growing. The awareness is “growing” largely because of the efforts of Americans abroad (including those who identify as Americans abroad and  “accidentals” who simply do NOT regard themselves as Americans). The following groups (working independently) have been responsible for this awareness:

Individuals with their blog posts and individual comments:

1. Third Party blogs (including Facebook sites) and Twitter handles which have provided “meeting places” for those affected by the clear injustices of “citizenship taxation”. The Issac Brock Society and Maple Sandbox are some of the best examples. In the legal community Phil Hodgen,  Virginia La Torre Jeker and Robert Wood are examples of lawyers who have consistently raised awareness of the problems of citizenship taxation. There are many other bloggers have contributed to the progress.

2. Individual Commenters on the blog posts

Participants in these forums have provided rich commentary to be used by those lobbying the government. Furthermore, your FATCA – StopFATCA.ca lawsuit – has been funded by individuals.

Organizations with identifiable managers and members

3. Defined Groups which include American Citizens Abroad and AARO have done excellent research and have done a good job lobbying various branches of the U.S. government.

The IRS

4. The IRS Taxpayer Advocate – Nina Olsen has worked very hard on highlighting the injustice of the IRS Offshore Voluntary Disclosure Programs.

5. The IRS itself – The IRS treatment of Americans abroad in the Offshore Voluntary Disclosure Programs has been inexcusable. That said, the June 2014 changes to the “Streamlined Compliance Rules” are probably an honest attempt by the IRS to allow Americans abroad to “clean up” most past tax problems on a “penalty free” basis. Remember that the IRS cannot change the law. But, the IRS can create a “penalty free environment”.

My point it that:

By creating a “penalty free environment” for Americans abroad to become tax compliant, the IRS has shifted the focus to THE LAWS OF CITIZENSHIP TAXATION THEMSELVES and away from the PENALTIES FOR NON-COMPLIANCE. By creating a “penalty free environment” the IRS has made it clear that the problems are more the LAW creating “citizenship taxation” and less the administration of the law. I believe that the IRS would support a repeal of “citizenship taxation”. It is a huge headache for them as well. (The IRS is as much a victim of “citizenship taxation” as any other person or group.)

Executive Branch – The Obama Administration

6. More of “The Good, the Bad and the Ugly”:

The Good: The 2015 Obama budget (regardless of how you perceive it) does qualify as a recognition on the part of the Obama administration that the rules of “citizenship taxation” are resulting in clear injustices.

The Bad: By attempting to release a small group of people from the “prison of citizenship taxation”, the Obama administration is strongly supporting “citizenship taxation” for those who remain. The 2015 Obama budget is a commitment to the principle of “citizenship taxation”.

The Ugly: The Obama administration has raised the fee to renounce U.S. citizenship from $450 to $2350. (I predict the fee to renounce will continue to rise.)

Congress

7. The Senate Finance Committee is involved in tax reform. As you know the Republican side of the Committee has expressed a preference (citing the research of ACA) for a move to “residence based taxation” for Americans abroad.

Legal Academics

8. Awareness of “citizenship taxation” has reached the academic community. The May 2, 2014 debate on Citizenship Taxation in Toronto was based on largely on the papers of Professor Michael Kirsch and Dr. Bernard Schneider.

Professor Ruth Mason of the University of Virginia Law School has written a paper on citizenship taxation. Professor Allison Christians of McGill law school and Professor Reuven Avi-Yonah of the University of Michigan Law School are the organizers of an academic conference on “Citizenship Taxation” which will take place on October 9, 2015 at the University of Michigan. Further information is here.

The law school classrooms

9. It is encouraging to see that “citizenship taxation” is being considered in law school classes. Two recent examples include:

A. The tax policy and law workshops at the Peter A. Allard School of Law – University of  British Columbia. On Friday February 27, 2015, Professor Ruth Mason discussed her recent paper on “citizenship taxation”.

B. The Tax Policy and Public Finance Colloquium and Seminar run by Professors Daniel Shaviro and Alan Viard of NYU law school. On Tuesday March 3, 2015 Professor Ruth Mason was in attendance to discuss “citizenship taxation”.

Professor Daniel Shaviro commentary on the Ruth Mason presentation – March 4, 2015

Professor Shaviro’s perceptions of “citizenship taxation” (based largely on the Mason presentation) appear as a separate blog post here. His post identifies (and categorizes) many of the “theoretical concerns” of “citizenship taxation”. He begins by saying:

Yesterday at the colloquium, Ruth Mason discussed her paper, Citizenship Taxation.  I enjoyed reading it enough to conclude that I may want to write about this topic as well.  (I generally agree with the paper, but it’s a rich topic and perhaps a fruitful area for me to deploy some of my interests and approaches.)

His post contains 10 interesting points. I would like to identify what I consider to be the most interesting and important two:

(5) The basic paradox: if you’re “us” and we care about you, you lose.

Once we accept that we can’t, and generally won’t even try, to “tax all foreigners living abroad,” something that is at least facially paradoxical arises when we consider taxing at least some nonresident citizens on their foreign source income.  This tax burdens the individual who has to pay it.  So we are effectively saying: “If we care about you, we’re going to burden you.  If we don’t care about you, because we have decided not to classify you as a member of our community, then we’re not going to burden you.

Now, one thing we clearly do care about, when taxing members of our community whether they are currently residents or not, is deadweight loss that we impose on them through our rules.  We don’t necessarily care directly about deadweight loss that is imposed on non-members, since we are at least mainly excluding all “thems” from our social welfare function, but for “us” it matters.  And this is pretty much the proof that the current U.S. regime for taxing nonresident citizens is defective and needs to be revised.  It appears to impose a lot of deadweight loss, from compliance burdens and the like, relative to the revenue that is actually raised.  This results, for example, from tax filing requirements who owe little or no U.S. tax (e.g., due to the earned income exclusion plus foreign tax credits).  Now, we may gain valuable information from the filing (or, rather, we would if people actually filed), but this is still a serious concern.

A question meriting further thought: Why don’t we extend more transfers or other social welfare, safety-net style benefits to non-resident citizens?  Perhaps there are good reasons for not doing so, but at the least it requires further thought.  Presumably if we had greater tax-transfer integration, such as via a Mirrleesean demogrant / income tax system, we would at least consider giving the demogrant to non –resident “us.”  Or perhaps not, if there are particular incentive issues to keep in mind here.  But worth some thought in any event.

Circling back to “us” versus “them”: Suppose we can tax U.S. citizens living abroad, but we classify these individuals as “them” rather than “us.”  Only, suppose that, because they are arguably “us,” we can get away with it – other countries won’t start to scream, retaliate, etcetera.  Then we would have a “them”-based reason for imposing the tax (and also for withholding welfare benefits and not caring so much about deadweight loss).  In short, it could be the one case of “Tax all foreigners living abroad” that we could actually pull off.  And this would imply not caring so much about deadweight loss that we impose on nonresident citizens.  But it does strike me as a bit harsh.

(10) Exit tax

Code section 877A generally requires tax expatriates to pay tax on a deemed sale of their assets for fair market value.  The tax only applies to net gain in excess of $600,000.  This exit tax makes up for the fact that, once you’re gone, the built-in gain from the period when you were still a U.S. citizen is unlikely ever to be taxed here.  So one could view it as anti-windfall gain, rather than as aiming to be punitive.

That characterization of the provision would be more solid and beyond dispute if we taxed net asset appreciation at death, rather than allowing a tax-free step-up in basis at that time.  But, for what it’s worth, the provision can indeed reduce lock-in on the part of individuals who are considering expatriating.

Here is a further issue that might be worth thinking about.  Suppose someone who might owe estate tax liability at death expatriates before that point.  Proponents of the estate tax might support treating expatriation as a triggering event for levying the tax.  Not just because “You’re dead to us now,” but to avoid creating the incentive to expatriate for that reason.

It would be useful to use Professor Shaviro’s “10 Points” as the basis for an extensive paper. By identifying many of the relevant issues, Professor Shaviro’s “short post” is a valuable contribution to the academic research on “citizenship taxation”.

Concluding thoughts …

U.S. persons abroad (citizens, Green Card holders, those who meet the substantial presence test) continue to live the absolute nightmare of the injustice of the U.S. extra-territorial policy called – “citizenship taxation”. The advent of FATCA means that this is likely to get much worse before it gets better. Many are “voting with their feet” and simply renouncing U.S. citizenship.

The first step in change is “awareness of the problem”. In 2009 almost nobody was aware of “citizenship taxation”. Because there was no awareness there was no discussion. “Citizenship taxation” was completely invisible. Its effects were neither known nor discussed. We are now in 2015. The combined efforts of the individuals and groups mentioned above have generated an awareness of U.S. “citizenship taxation” as a major problem.

U.S. “citizenship taxation” is a problem for:

1. The individuals affected by it.

2. The countries where U.S. citizens reside which are required to accept the capital outflows inflicted by “citizenship taxation”.

In 2009 few would have imagined that the problems of “citizenship taxation” would be given the attention that they are today.

As they say in the Marines:

“The difficult we do today. The impossible takes a bit longer.”

Keep up the great work! Keep the faith!

John Richardson

ADCS-ADSC Co-Chair and Legal Counsel

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